Alive and Kicking: A Guide to FX as an Asset Class

Authors

George Saravelos

Strategist

+44(20)754-79118

george.saravelos@db.com

Shreyas Gopal

+44(20)754-51501

shreyas.gopal@db.com

Oliver Harvey

+44(20)754-51947

oliver.harvey@db.com

Vivek Anand

vivek.anand@db.com

Robin Winkler

+44(20)754-71841

robin.winkler@db.com

Gautam Kalani

gautam.kalani@db.com

Rohini Grover

+44(20)75475907

rohini.grover@db.com

Caio Natividade

+44(20)754-55917

caio.natividade@db.com

www.dbresearch.com

With trillions in currencies exchanging hands every day, foreign exchange is indisputably the world’s largest and most liquid financial market. Yet in spite of its size, this report argues that it is also likely to be the least "efficient" compared to other asset classes.

We review the latest data from a wide range of sources and conclude that only 45%-60% of forex (FX) market participants are likely to be profit-seeking. The presence of a large portion of non-profit maximizing participants explains why the efficient market hypothesis fails to hold in currencies and why FX moves can be both predictable and profitable. The rising share of passive investors as well as the increasing importance of regulation suggests that the FX market may be becoming less, rather than more efficient over time.

We review the returns provided by investing in the currency markets since the 1980s and find no evidence of deterioration over time. A simple rules-based approach using the Deutsche Bank Currency Returns index (dbCR) involving carry, valuation and momentum strategies has provided stable risk-adjusted returns that have been resilient even after the shocks of the 2008 financial crisis.

We also find consistent evidence of positive FX manager returns and introduce a number of new trading strategies.

We compare FX market returns to bonds and equities and show that currencies have offered comparable risk-adjusted returns compared to a global fixed income or equity portfolio since the 1980s.

We show that the addition of FX to a bond and equity portfolio has material diversification benefits by reducing volatility and the drawdown of returns.

We explore the drivers of FX hedging and evaluate the merits of dynamic currency overlay.

We argue that hedging always involves an opportunity cost and even profit-constrained or transactional participants need to carefully consider their approach to FX.

We conclude that currencies as an asset class are "alive and kicking" and that the FX market is likely to continue to offer excess returns to investors for the foreseeable future.

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The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author, which do not necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinions expressed may differ from views set out in other documents, including research, published by Deutsche Bank. The above information is provided for informational purposes only and without any obligation, whether contractual or otherwise. No warranty or representation is made as to the correctness, completeness and accuracy of the information given or the assessments made. In Germany this information is approved and/or communicated by Deutsche Bank AG Frankfurt, licensed to carry on banking business and to provide financial services under the supervision of the European Central Bank (ECB) and the German Federal Financial Supervisory Authority (BaFin). In the United Kingdom this information is approved and/or communicated by Deutsche Bank AG, London Branch, a member of the London Stock Exchange, authorized by UK’s Prudential Regulation Authority (PRA) and subject to limited regulation by the UK’s Financial Conduct Authority (FCA) (under number 150018) and by the PRA. This information is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. and in Singapore by Deutsche Bank AG, Singapore Branch. In Japan this information is approved and/or distributed by Deutsche Securities Inc. In Australia, retail clients should obtain a copy of a Product Disclosure Statement (PDS) relating to any financial product referred to in this report and consider the PDS before making any decision about whether to acquire the product.

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